If you’re the HR director of a small or mid-size company, you’re probably familiar with the list of investments available to employees under your 401(k) plan.
Yet, chances are that no one at your company knows how your plan ended up with its particular selection of investments. That’s because these plans typically aren’t bought, but aggressively sold – by large insurance companies acting as plan providers.
Often, the fees these they charge are far too high, relative to the market, for the services being provided – a widespread reality that the federal government is trying to change by requiring employers to take steps to assure that these fees are reasonable.
This requirement is part of a larger regulatory effort to prompt companies sponsoring 401(k) plans to take a hard look at them. When scrutinizing their plans, many companies will find shortcomings including too few investments and lack of care in their selection. Answering the question of how investments got into their plans opens up a Pandora’s box of issues.
Many companies will realize that they’ve failed to adequately monitor the performance of investments in their plans or to assure that the risk/reward characteristics are fully explained to employees who depend on these plans to provide income during retirement.
When companies sign up for pre-packaged plans that may be deficient, they sincerely believed they were getting a good product. After all, large insurance companies have to be accountable for the integrity of their products because they have substantial legal liability for their suitability, right? Wrong. As plan sponsors, employers – not plan providers -- carry substantial civil and regulatory liability for their 401(k) plans.
Amid the examination of the plans that new federal rules will spur in the coming months, many employers will come to grasp the full extent of their legal responsibility – their fiduciary liability – for the first time.
These employers – as well as those who already have an inkling or even a full awareness of their fiduciary role – will be seeking tools to guide them through the process of evaluating and revamping their plans.
The most critical tool available for this purpose is an investment policy statement (IPS). This document includes a detailed list of a plan’s investments, the selection criteria used for their inclusion, how these criteria pertain to the company’s particular worker population, the monitoring processes used to continuously evaluate investment performance, the performance benchmarks these investments’ must meet to qualify for and remain in the plan, the governance processes the company uses to make substantive changes, provisions for disclosure of information on investments to employees, descriptions of programs for educating employees on investing concepts so they can understand these disclosures, and on and on.
Thus, an IPS is a soup-to-nuts blueprint for the plan, its administration and its ongoing maintenance. But a good IPS doesn’t stop there. It is a living, breathing document that shifts with long-term investment market trends and changes in employee demographics. It should be constantly re-evaluated and slavishly adhered to. If you’re changing any aspect of the plan, do these changes comport with the governance principles and guidelines set down in the IPS? They’d better – or else the company could lose sight of the plan’s goals, jeopardizing its capacity to influence positive retirement outcomes.
Investment policy statements aren’t just used by 401(k) plans. They are widely used by investment advisors, trust administrators and other financial fiduciaries to establish mutually agreed-upon principles and criteria for managing assets according to clients’ goals and risk tolerances.
In a sense, 401(k) plans themselves are financial planners insofar as they include investment options – though ultimately, investment choices are up to employees. An IPS for a 401(k) plan should bridge the gap between the plan and each employee to guide investment choices. And, just as financial advisors with integrity serve their clients in their best interests, communicating clearly about such issues as risk versus reward and allocating assets to achieve sufficient portfolio diversification, an IPS should assure that plans give employees a sufficient variety of choices to meet their goals and empower them to make the best choices.
Drafting an IPS should be the first thing a company does when establishing a 401(k) plan. And in a perfect world, this is what all companies would do. Many large-company 401(k) plans have investment policy statements – or something akin to them. But to HR managers and owners of many smaller companies, “IPS” understandably might sound more like an overnight parcel delivery service than a critical financial document that can determine whether employees have to keep working into their 70s and 80s.
Because of the new rules, many HR people at smaller companies will have to considerably increase their knowledge of how 401(k) plans are supposed to work – or their companies may risk severe regulatory sanctions from the U.S. Department of Labor.
Companies can start by obtaining a clear view of their plans to determine their deficiencies and decide what to change. Those changes should be reflected in an IPS which, if constructed correctly and followed carefully, can help companies exercise a high level of due diligence that can keep regulators and lawsuits away.
If you don’t know what an IPS is, it may be next to impossible to construct one yourself. In this case, it’s probably best to engage the services of an independent advisor who can also X-ray your plan and suggest changes.
If you or anyone at your company can remember the meetings with the broker who sold your company your 401(k) plan, you’ll recall that these sales people didn’t offer to construct an IPS. That’s because this is a service provided by fiduciaries. Plan providers and brokers avoid this status – and its attendant liability – like a bad rash.
To stay ahead of regulators, there’s much work to be done. The benefits of doing this hard work go far beyond staying out of trouble. Assuring that your company provides competitive benefits that help employees retire with dignity isn’t just the right thing to do; it can also aid recruiting and increase employee retention.
And when an employee asks how your plan’s investment selection came to be, you can pull out the IPS and read them the reasons.
Anthony Kippins is president of Retirement Plan Advisors, Ltd., a Registered Investment Advisory firm that addresses the needs of retirement plans and the employees who invest in them.
An Accredited Investment Fiduciary Analyst (AIFA®) with more than 30 years of experience domestically and abroad, Kippins specializes in providing fiduciary advice to retirement plans on governance, investments and educational services. He also advises individual clients on retirement planning and investment management after retirement.
Kippins also serves as managing director of Institutional Fiduciary Assurance LLC, an organization that provides fiduciary advice to trustees of endowments, foundations, non-profit organizations and charitable trusts. He can be reached at email@example.com.